How corporations avoid paying income taxes

Published 4:00 am, Thursday, April 21, 2011

With all the talk about how companies like General Electric and Cisco pay no or very low U.S. taxes, reader Hal Helfan of Oakland wants to know why can't there be an alternative minimum tax for corporations like there is for individuals, to make sure that companies can't use loopholes to wipe out their tax burden.

"If the AMT rate were set appropriately, it would probably be easier to lower the corporate tax rate and would definitely be a boon to small corporations that don't get much benefit from tax credits," he writes.

In fact there is a corporate AMT, and it works very much like the individual AMT.

Corporations figure their tax under the regular system, which taxes corporate profits at a top rate of 35 percent. Then they figure it under the AMT system, which tosses out some deductions allowed under the regular system, and taxes the resulting profit at 20 percent. The corporation then pays whichever tax is higher.

Many large corporations are subject to AMT, especially capital-intensive companies that lose depreciation and other deductions under AMT.

But there are two problems with the AMT. Although it's extremely complex to comply with, it's not all that tough.

More important, it does not apply to the profits that U.S. companies earn or purport to earn abroad. U.S. multinationals have found myriad ways to shift profits to foreign tax havens.

These companies do most of their business in the United States and other moderate-tax countries such as Germany, England and Spain.

But they often put their intellectual property - such as trademarks or patents - into subsidiaries in low-tax countries such as Switzerland, Ireland, Bermuda or the Cayman Islands.

When one of the company's subsidiaries in a higher-tax country sells a product, it pays a royalty to the subsidiary in the tax haven. That shifts profits to the low-tax country, while the subsidiary in the high-tax country gets a tax deduction for the royalty payment.

"The income is taxed at a lower rate, and the deductions are enjoyed at a higher rate," says Robert Willens, a Wall Street accounting expert.

Cutting overseas tax rates

There are other ways companies can reduce or avoid tax on foreign profits. Bloomberg Businessweek reported that Google used a convoluted process known as the "double Irish" and the "Dutch sandwich" to cut its overseas tax rate to just 2.4 percent between 2007 and 2009.

General Electric, according to the New York Times, paid no U.S. taxes for 2010 despite reporting worldwide profits of $14.2 billion, including $5.1 billion in the United States. It used a variety of tax breaks including an "active financing exclusion" that lets it defer U.S. tax on foreign lending income.

U.S. companies generally pay no tax on their foreign profits until they repatriate them or bring them back home.

Rather than pay the tax, most U.S. multinationals let their overseas profits accumulate offshore until they can persuade Congress to give them a tax holiday on repatriated profits.

In 2004, Congress passed a law that gave U.S. companies a one-time chance to repatriate their foreign profits at an effective tax rate of 5.25 percent. (The actual rate was closer to 3.7 percent after foreign tax credits.)

Congress bought the companies' argument that they would use the profits to increase spending and hiring domestically and that getting 5 percent in tax would be better than getting nothing if the companies never brought their earnings home.

Companies were supposed to develop a plan for how they would use the money. Approved uses included hiring and training U.S. workers and investing in research, development and infrastructure. Prohibited uses included executive compensation, shareholder dividends or stock buybacks.

However, they were not required to submit their plans to any government agency nor to trace or segregate the repatriated funds.

Repatriations, then layoffs

According to the Internal Revenue Services, 843 corporations took advantage of the holiday to repatriate $362 billion, of which $312 billion qualified for the tax break.

Although companies say they used the money as Congress intended, several studies found they did not.

A study published last year by the National Bureau of Economic Research found that repatriations "did not lead to an increase in domestic investment, employment or R&D - even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders."

A report by the Center on Budget and Policy Priorities said that companies including Hewlett-Packard, Pfizer, Ford, Merck and Honeywell announced large layoffs shortly after repatriating funds.

Now companies such as Cisco, Oracle and Google are lobbying for another repatriation holiday, saying it could bring back up to $1 trillion in foreign earnings.

In a blog post, Cisco chief John Chambers said that $1 trillion is "an amount larger than the original stimulus. Imagine what an injection of hundreds of billions of dollars in capital could do for the country."

But the Center on Budget and Policy Priorities says "a second holiday would send a powerful message to corporations to shift investment and jobs overseas and hold the profits there - until yet another tax holiday is declared. Indeed, enactment of another such holiday would further embed the shifting of investment, jobs and profits overseas as a major tax avoidance strategy for many U.S. multinational corporations."